When we make decisions we nearly always do so in the context of something or other. In fact about the only time we're asked to make contextless choices is in academic exams and laboratory based psychology experiments. As these are the two most familiar situations faced by the academics generating the theories that underpin most of modern finance we shouldn't be awfully surprised if their great ideas are somewhat lacking in any understanding of … well, anything, really.Being trained to think logically and probabilistically is a necessary part of being a modern economist, but it's hardly a requirement for most people in most professions most of the time. You don't find many baristas trying to make Bayesian inferences about which particular coffee to pour next. We clearly don't rationalise most decisions, we make them quickly and effortlessly.
We don't optimise, we satisfice.
Satisficing Simon
Satisficing is a concept introduced by Herbert Simon, who argued that people didn't attempt to solve problems and make judgements in an optimal manner, but merely in a way that was sufficient and satisfying – hence, satisficing. This approach contrasts with both the ideas of classical economics and of the mainstream of behavioural finance, which set up a norm of rational behaviour to measure people against. In the former case the expectation is that people will act in accordance with these principles, in the latter that they will try and fail and, in so doing, generate predictable irrationality: so called behavioural biases.
Now while it's undoubtedly true that the behavioural approach has taken us away from a standard of rational behaviour that not even the most anally-retentive classical economist could hope to match it also seems that the underlying focus on there being some kind of goal of rationality that we're to be measured against has generated its own biases. Some of the results of this research program simply don't make sense when translated to the real world, and increasingly it looks like these deviations occur because there are errors at the heart of behavioural finance.
Simon's idea wasn't just that we weren't achieving some great goal of rationality but that we weren't even bothering to try, thus rendering a large part of the research program of behavioural finance irrelevant. After all, if you're consistently scoring people against the rules of snap when they're playing bridge, you're going to…
